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July 6, 2021

The Rise of Cryptocurrency: Breaking Down the Basics of Bitcoin and Tax Treatment

Cryptocurrencies such as Bitcoin and Ethereum have become a very popular headline lately. What was once “internet funny money” is now gaining traction as a popular investment tool and even as a means of transaction. Large institutional investors and some publicly traded companies such as Tesla and MicroStrategy are beginning to add Bitcoin to their balance sheet. Many well-known investors like Mark Cuban, Kevin O’Leary and Tom Brady are also adding cryptocurrencies to their investment portfolios. With adoption and use cases coming with digital currencies, it’s important to understand the potentially changing landscape of the financial industry. While there are many questions and uncertainties around the cryptocurrency space, there are many properties of cryptocurrencies and their blockchain technology that have begun to attract investors as well as many of the brightest minds to develop and innovate in the growing space.

What is Bitcoin?

Bitcoin (BTC) is the very first cryptocurrency ever created. The creator of Bitcoin is still anonymous to this day as the creator has gone by the pseudonym “Satoshi Nakamoto”. Bitcoin itself isn’t a physical item; instead, Bitcoin is a software on a public ledger that anyone in the world has access to. Every transaction on the Bitcoin blockchain is anonymous as the owner of the Bitcoin wallet isn’t identified in the transaction. However, every transaction can be traced and confirmed to and from each person’s wallet as public information, so it’s also transparent. Bitcoin isn’t backed by any government or any institution, and the value of Bitcoin is determined by the people, just like gold. Bitcoin has been referred to as “digital gold” for this exact reason.

Why Bitcoin?

One of the main draws of Bitcoin is its properties as an inflation hedge. Bitcoin has gained momentum recently at a time when money printing and stimulus payments are at an all-time high. About 20% of all US dollars were printed in 2020. Not only is the money supply increasing, but interest rates are low. As “digital gold”, Bitcoin has store of value properties in a time of potential inflation. Bitcoin is a scarce asset in that it has a fixed supply of 21 million. There can never be any more Bitcoin than that amount. There is not enough for every millionaire in the world to even own ½ of a Bitcoin. Currently, just over 18.7 million Bitcoin are in the circulating supply with the remaining 2.3 million yet to be mined into circulation.

Another benefit of Bitcoin is that it can be used as a peer-to-peer transaction technology, thus eliminating the need for a third party. The Bitcoin network is up and running 24/7, 365 days a year and payments can be processed quickly. Bitcoin can be sent from one wallet anywhere in the world to another wallet anywhere in the world within 20-30 minutes without the need of multiple third parties to finalize the transaction. The 2-3 day waiting period for transactions to clear when involving third parties is eliminated with the Bitcoin network.

What are the Tax Implications of Bitcoin?

Currently in the United States, Bitcoin and all other cryptocurrencies are regulated as a property for income tax purposes. Each sale of Bitcoin or any other cryptocurrency is considered a capital transaction. Even a swap directly from one cryptocurrency to another, such as Bitcoin to Ethereum, is a transaction that is subject to capital gains or losses.

Depending where you live in the world, the tax implications can vary. The country of El Salvador recently passed a law declaring Bitcoin as “legal tender” in their country, making it not subject to capital gains tax. As further regulation is passed, both within the United States and internationally, the tax implications will continue to evolve regarding the buying, selling and mining of Bitcoin. Future blog posts will discuss the effects in greater detail.  

Bitcoin is potentially just the tip of the iceberg in a vast world of digital currencies and decentralized finance that is starting to gain traction as a legitimate asset class. If you or your business have any questions about the tax implications, Anders is here to help. Please contact an Anders advisor below to learn more.

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